Capitulation

Capitulation is defined in the American Heritage Dictionary as the following:

ca-pit-u-la-tion (n)

1. The act of surrendering or giving up. Surrender. 2. A document containing the terms of surrender.

In Wall Street the term refers to the time when investors (all of them) sell all their stocks because they want out. The sole motivation for trading is to get out of the market and seek shelter in “safe” investments such as bonds or your mattress. The selling frenzy is painful, but relatively quick. Consequently, a sign of capitulation is mass selling that occurs over a brief time span.

As I write this on Monday night, the signals are not good. In London trading, future contracts on the Dow Jones Industrial Average were pointing to a more than 500 point drop. Trading in India was down more than 11% and halted. Hong Kong’s Hang Seng index was down more than 8%; Japan’s Nikkei index is down 5% and has suffered its biggest two-day drop in 17 years; Taiwan is off 6.6%. The major European bourses all suffered large declines on Monday, with losses of more than 7% in Germany and nearly 5.5% in the U.K.

Monday night here in California, I took a look at some of the major Asian and European tech shares, and the news is not good.

In Taiwan, shares of Taiwan Semiconductor (TSM) are down 7%.

In Tokyo, Yahoo Japan is down 7.4%.

Also in Tokyo, Sony (SNE) is down 5.3%, while Toshiba is down 5.1%.

In German trading, SAP on Monday was down 9.7%.

In Finland, Nokia (NOK) shares were off 6.3%.

In India, all of the leading outsourcing stocks were hard hit, with Wipro (WIT) down 7.9%, Satyam (SAY) down 4.5% and Tata Consultancy Services down 8.5%

In South Korea, Samsung shares are down 10.2%.

In Hong Kong, Alibaba.com shares have dropped 10%.

Also in Hong Kong, China Mobile (CHL) shares are are down 6.5%.

This all feels uncomfortable like October 1987. I would note that even before the infamous 22%-point drop on Black Monday, the Dow Jones Industrial Average had already fallen close to 20% from its peak. I wrote an opening market comment that day — yeesh, I’ve become an old timer — which noted that stocks had dropped dramatically in overseas trading heading into the opening in New York. I know that conditions are hardly identical in many ways, but this does not feel good to me. Not good at all.

From MarketWatch this morning: “Over two days, the Nikkei 225 dropped over 10% in Tokyo, and the DAX-30 fell about 10% in Germany.”

From one of Dow Theory Letter editor Richard Russell’s recent notes:

Now the foreign markets, Hong Kong, China, Europe, are starting to break down. Let me put it this way — we’re watching a deadly international bear market, one that is pressing down on every stock exchange on the planet. How it will all work out I honestly don’t know. I’ve lived through a number of bear markets, but this one is shaping up as a “biggie,” a real brute. That’s my instinct, that’s my intuition, that’s my opinion after 63 years of studying and dealing with markets.

Global panic has hit the stock market. A plunge at the open is clearly indicated. . . . The market drop today is essentially on no news. That doesn’t matter much, however. This is not like the sell-off in February 2007 in which a quick rebound occurred. These fears aren’t going away overnight.

The latest selling looks to have spun out of control. I would not be surprised to see a final big spike down as everybody finally swears off stocks forever — again.

Yet, interest rates will come down, earnings won’t be so bad, oil prices will drop, food costs will drop, credit markets will crank up, political candidates will talk about America’s strengths, and this downdraft, too, shall be lost in the long-term uptrend that is the stock market.

Stocks are cheap. The S&P; 500 is down nearly 10% so far this year, and the year’s not even three weeks old. The P/E ratio on the index is almost down to 13. Remember the great buying opportunity in 2002 following the bulk of the dot com bubble burst? Now that was a bear market, and yet the S&P; 500’s P/E was 15, not quite as cheap as it is now. So, even if earnings weaken from here, we have room for the P/E to rise and still find stocks cheap.

There’s another measure showing stocks to be cheap. The forward earnings yield on the S&P; 500 is over 7%, twice the 3.6% yield on the 10-year Treasury note. That kind of disparity has never lasted long.

Then the big news hit at 8:25 this morning: The Federal Reserve cut its overnight lending rate by 75 basis points to 3.50%.

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